Here's why ASX ethical investing is not as good as it seems

Here's why ASX ethical investing might not be as good as it seems.

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A rising trend in the world of ASX investing over the last few years has been 'ethical investing'. Also known as 'Socially Responsible Investing' or SRI – ethical investing aims to give retail investors more of a say in the shares that their money buys.

What a good idea! Right?

Well, it sounds good.

See, a lot of investors invest in what's known as index funds – either through their own investments or through superannuation. Ethical investing normally concerns these kind of investments, because you already have a choice of where to invest if you own individual shares.

Index funds work by buying the vast majority of companies in a particular country – you essentially own everything on the market.

So for example, a S&P/ASX 200 index fund like the iShares Core S&P/ASX 200 ETF (ASX: IOZ) is a single stock that within itself holds the 200 largest companies on the ASX. The biggest shares like Commonwealth Bank of Australia (ASX: CBA) have more weight in the index and fund than smaller companies like Zip Co Ltd (ASX: Z1P).

You get the good, the bad and the ugly – all in one neat package.

Investors love index funds because they're easy to invest in, you don't have to worry about choosing stocks yourself (you can just buy and hold forever in theory) and they're relatively cheap. IOZ charges a management fee of just 0.09% to illustrate.

But the problem for many investors lies in the above description – you get the good but also the bad (and the ugly). And many investors don't want the latter.

What companies aren't 'ethical'?

You may be concerned about climate change and not want your money in a coal company like BHP Group Ltd (ASX: BHP) or an oil company like Woodside Petroleum Limited (ASX: WPL).

You may not agree with gambling and view it as morally wrong – and so might not be too fond of poker-machine maker Aristocrat Leisure Limited (ASX: ALL).

Yet all three of these companies are in the ASX 200 and will be part-owned by anyone who has exposure to an ASX 200 index fund. You will receive dividends from these companies as part of your distributions, which are funded by the sale of the above products.

International ETFs are perhaps worse from an ethical standpoint.

You may not like smoking or drinking and hence don't want to invest in tobacco companies like Philip Morris International or beer brewers like Anheuser Busch InBev.

Fast food might be an anathema to you and so too the idea of investing in McDonald's Corporation.

You might see nuclear power as a threat to the planet and hence would not be interested in a uranium miner like Blue Sky Uranium Corp.

You might not like the idea of a company making weapons of war, such as Lockheed Martin or Boeing.

Yet all of these kinds of companies are included in your typical 'international' index fund – such as the Vanguard MSCI Index International Shares ETF (ASX: VGS).

But what makes a company 'bad' (or ugly)? Well, that's a subjective question – not everyone's ethics align perfectly.

Alternatively, you may work in the mining industry and not have a problem investing in the company that's hired you.

Or you may love a beer and would like to support your favourite brewing company.

You get the idea. Not everyone's ethics are the same.

But in a typical 'ethical' fund, fossil-fuel miners, 'sin' stocks (like tobacco and alcohol producers) and weapons makers are all usually excluded. It does vary from fund to fund with other ethically-questionable industries like pornography, chemical manufacturing, logging and meat production sometimes thrown in. But most ethical funds are broadly consistent with these 'filters'.

Are there ethical options available on the ASX?

Indeed there are. One example is the BetaShares Australian Sustainability Leaders ETF (ASX: FAIR) – which follows an 'index' of ethically-screened ASX companies. BetaShares also offers the BetaShares Global Sustainability Leaders ETF (ASX: ETHI) – which does the same on a global level.

Australian Ethical Investment Limited (ASX: AEF) is a fund management company that specialises in offering ethical managed funds. This company has seen its shares skyrocket over the past year as it experienced a huge rise in popularity.

The problem with ethical investing

Of all the good that comes into a decision to go for an ethical investment, there's an unfortunate truth that the providers of these funds probably won't tell you.

Not investing your money in a 'non-ethical' company doesn't actually hurt the company. At all. Just like buying your favourite company doesn't really help that company (although hopefully, it helps your wallet).

Most shares are traded on what's called a secondary market. That means you're buying and selling from other investors, not the company itself. Buying a company's shares doesn't mean you're giving the company your money, you're giving it to whoever owned the shares before you.

Just think of shares like second-hand cars. Buying a Ford from your neighbour doesn't benefit Ford Motor Company in any way whatsoever. And boycotting second-hand Fords only makes them cheaper for others who want to buy them by reducing the overall demand in the market.

It's the same principle for investing in shares. Boycotting BHP shares because you don't like coal mining only makes them cheaper for those who still want them. Or even for the company itself, who also always has the option to buy back its own stock. BHP's revenue, profits and dividend payments won't be affected – you are just making it cheaper to access those profits for other investors.

If that wasn't true, tobacco companies wouldn't have been one of the best stocks to invest in for the last hundred years. People have hated tobacco companies for decades (for good reason) – yet that hasn't stopped their shareholders making money hand over fist.

If you really want to help or hurt a company – there's only one way to do it. Either buy or stop buying what that company is selling and tell your friends to do the same. That's it.

Now I understand if you as an investor can't sleep at night knowing you're profiting from the sale of coal, oil, tobacco or alcohol. If that's the case, then avoid by all means! Just don't kid yourself that it's hurting those companies. In a perfect world, perhaps it would. But alas, Utopia remains out of reach and so does this pipedream.

Foolish takeaway

Don't let anyone (including this writer) tell you what and what not to invest in. But if you're paying double the fees that you should be because you think your investing choices are saving the world, you might want to rethink your strategy. As Mark Twain once said "It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so".

Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of Australian Ethical Investment Ltd. and ZIPCOLTD FPO. The Motley Fool Australia has recommended Australian Ethical Investment Ltd. and Vanguard MSCI Index International Shares ETF. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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